Infrastructure’s role in keeping egg prices high

It seems that the egg industry may find itself in a position of economic prosperity previously unmatched in its long, tumultuous history.

Greece had its Golden Age around 440 BCE, Bill Clinton has claimed one for the United States in the 1990s, and now the U.S. egg industry is finally having its turn. Egg prices have soared at historic highs through months in which producers usually hold on for dear life. In the past, one could always expect to see a crash in prices directly after profitable periods, due to the nature of commodity markets. Today, however, there are dozens of variables affecting the egg market that could stave off a price crash for some time. The purpose of this report is to investigate how the industry came into such a profitable position and what the market is likely to do in the short-term future.

Among the reasons why the industry is so profitable now are: changes in cage space due to the requirements of the United Egg Producers (UEP) animal care guidelines, increased egg exports and an aging infrastructure coupled with the terrible market the industry experienced throughout 2005 and 2006. The short-term future of the industry has huge potential as well, especially with the continuation of trends that are likely to keep supply tight, including a reluctance to invest in new equipment, a huge number of old and obsolete cages currently in production, and a slew of other difficult-to-quantify variables. When all of the above factors are compounded, it seems that the egg industry may find itself in a position of lengthy economic prosperity previously unmatched in its long and tumultuous history.

Cage Space Attrition

Cage space attrition due to the requirements of the UEP guidelines and basic wear-and-tear have been the leading factors in keeping supply tight and prices high. While depreciation always has and always will be around, the UEP animal care guidelines are an evolving force in the industry that have caused some expected and some unexpected complications.

One basic effect of the guidelines' required increase in cage space is that, overall, the industry has lost about 20 percent of space available in existing houses, a trend which will continue through April of 2010, when all cages in the UEP program will have to provide 67 square inches per bird and 29 percent of space present in 2002 has been lost.

Of course, all of these changes only apply to participants in the UEP certified program, which includes 196 million cage spaces in the shell egg market and about 22 million in the egg product market, but for the time being this analysis focuses primarily on the shell egg market. Thus, from 2002 to the present day, the shell egg industry has already lost 37 million cage spaces to the UEP guidelines alone. Assuming a constant flock size of 196 million hens, the industry will go on to lose a total of 56.5 million by 2010.

Table No. 1 provides a rough year-by-year breakdown of the effect of the UEP certified program on the number of cage spaces available for shell egg production. The guidelines state that all birds hatched after each implementation date must be housed at the specified density. Thus, the actual conversion over to the space required can take up to two years for the whole industry, as shown by the gradual change in existing cage space. The percentages of producers at these space allowances are only rough estimates, intended to represent the progression of additional cage space across the industry. The only points that are absolutely certain are those at which 100 percent of the industry, enrolled in the UEP program, is at one size, as these deadlines are closely monitored by third party auditors. Of course, implementation of the UEP certified program is not the only reason for the industry's rapidly disappearing cages.

The wearing out of cages is another major factor that can help explain these extraordinary egg prices, especially because its effect is multiplied by both the guidelines and horrible markets of 2005 and 2006. Assuming an average cage life of 25 years and an initial shell egg flock size of 196 million birds in 2002, an average of 7.7 million cage spaces should be replaced by new ones each year, adding up to 46 million cage spaces since 2002 (Table No. 2).

Prior to New Guidelines

Prior to the implementation of the UEP's animal husbandry guidelines, most producers in the United States simply replaced old cages with similar A-frame systems. Today however, many producers are finding that A-frame, high-rise systems make it difficult to meet the requirements of the UEP guidelines, customer expectations and environmental regulations. As a result, when the time comes to replace the cage equipment in an older facility, in addition to increased space per bird, a producer must consider switching to a newer stacked deck or scraper board system rather than the familiar high-rise house. Stacked deck systems are much more complex and expensive to install, costing around $12 per bird rather than $5 per bird for high-rise. Additionally, these highly sophisticated systems require new management techniques and have higher operating costs.

While the high cost and lack of experience with non A-frame systems are two key factors, it is important to keep in mind that there are many concerns and barriers leading egg producers to hesitate spending their recent windfall on new cages. Some of these include:

Ever increasing environmental laws and regulations;

Constantly changing food safety and security laws and regulations;

Ballot initiatives in several states to outlaw caged egg production;

Legislative initiatives in several states to outlaw caged egg production;

Difficulty obtaining necessary permits for new or expanding facilities;

Heightened feed costs and instability due to an exponential increase in ethanol production.

This hesitance or inability to replace worn-out equipment is confirmed by information gathered from the cage manufacturing industry.

For the most part, producers have been able to keep up with demand by using any and all available funds to maintain older equipment or expand when possible. From the point of implementation of the guidelines in 2002 through about April of 2004, the industry stayed profitable and, as a result, it had enough money to keep up with the increased size requirements and to continue expanding.

The number of cages placed between 2002 and 2004 exceeds the number of cages required to make up for lost space and depreciation by about 16.7 million. The result of that over-expansion hit the industry hard, causing it to lose an average of $0.069 per dozen in 2005 and $0.071 in 2006, as reported by Don Bell in EEU report No. 279. According to the USDA, the industry produced 211 million eggs per day in 2005 and 214 in 2006, resulting in industry losses of $1.2 million every day in 2005 and $1.3 in 2006.

Aging Equipment

Since then, producers have been able to scrape by with a constant supply of birds mostly by filling up cages that may have been empty and by holding on to older, grandfathered cages for longer than what may be most efficient. New cage installation slowed to a virtual halt, but the surplus of cage spaces installed from 2002 to 2004 helped maintain supply levels. With aging equipment and constantly increasing cage space requirements however, producers can only hold on for so long, and by this point it seems that these factors combined with a general lack of investment in new equipment have caught up with the industry and are making it more difficult than ever to maintain a constant flock size, let alone expand.

Up to this point, most information regarding the number of cages installed referred to the egg industry as a whole, including egg products. This can be misleading when trying to look solely at the shell egg market because one phenomenon that has swept through the industry in the last six years is a huge increase in the number of in-line breaking facilities. While this kind of production only made up 34 percent of the egg breaking industry in 2002, today it makes up nearly 50 percent (Chart No. 1).

Growth of in-line breaking facilities has required the installation of an additional 23 million cages over the past 6 years. This higher level of investment by the industry has allowed it to better maintain its infrastructure with only 8 percent of its hens in obsolete facilities compared to 18 percent in the shell egg industry.

Another important change over the past few years has been the effect of continually increasing hen productivity. According to industry estimates, over the past six years, the industry has seen an increase in productivity equal to an extra 14 million birds, or a 5 percent increase. This would, of course, help to offset some of the reduced cage space if not for another important variable, the constantly increasing population of the United States. During the same amount of time that layer productivity increased by 5 percent, the U.S. population also grew by 5 percent, as reported by the U.S. Census Bureau. These two variables end up canceling each other out, and it is reasonable to assume that this relationship will continue at least for the next several years.

When one extends all of these trends a couple of years into the future, it is clear that there is no reason to expect its sustained prices to drop down below break-even levels any time soon. As shown in Table No. 3, an additional 47,000,000 cage spaces must be installed between 2008 and 2010 to keep the industry's infrastructure from becoming even smaller and less efficient.

Table No. 3 shows how much additional space is needed for UEP guidelines.

Summary

How long our industry will remain profitable is always difficult to predict and subject to many different interpretations. This report is an attempt to provide one point of view and hopefully stimulate additional discussion on the subject.

One important but unproven assumption we have made is that, with the Urner Barry large egg price over $1.60, every cage in the country that can hold a hen is probably full. If this is the case and we are as far behind in replacing older equipment as our numbers show, the industry has no way to increase production in the short term. If producers continue to follow the UEP animal husbandry guidelines, as appears likely, we can not quickly increase flock size by placing an additional hen in each cage. Planning and installing new cage equipment will take at least eight months to one year from beginning to end. Our basic conclusion is that whenever new construction begins on a large scale (and it does not appear to have started yet), we will have about one year of great egg prices before oversupply brings this exciting ride to an abrupt halt.